In response to recent concerns over high-risk private offerings such as Medical Capital and Provident Royalties, the Financial Industry Regulatory Authority (FINRA) has issued a Notice to Members (NTM-10-22) that reminds brokerage firms of their obligations to investigate private placements before allowing their representatives to sell those investment products. However, FINRA only regulates registered broker-dealers, and many such offerings are recommended or sold by financial advisory firms that are not FINRA-registered.
Private placements, often recommended as an alternative by investment advisers in smaller towns that are outside the financial industry mainstream, have recently come under increased scrutiny. Unlike public offerings, most private placements are not registered with the SEC, and because state laws and enforcement capabilities vary widely, many of these investment offerings fly beneath the regulatory radar until a scandal erupts. The exception to the Securities Act that allows these offerings to avoid SEC registration, commonly referred to as Regulation D, puts limits on the number of unaccredited investors who may be participate but does not limit the number of accredited investors (presently defined by SEC rules to include a individual or married couple having a net worth in excess of $1 million, or income in excess of $200,000 for two or more consecutive years in the case of an individual or $300,000 jointly for a couple). Sometimes abuses occur because investors who do not qualify as “accredited” are misclassified as such.
Other common abuses are misrepresentation of the risks, which are typically higher than for public offerings that must be registered with the SEC, or the failure to disclose material facts?that is, information, that would cause an investor not to invest were that information fully disclosed in advance. Perhaps the most common abuse is the failure of the broker or financial adviser to make sure that the investment is suitable, both generally from the standpoint of the investing public and specifically in relation to the investment objectives of the individual customer. For example, if the investor has recently retired and the broker/adviser puts the investor’s entire retirement savings into a risky private offering when the investor has conservative investment objectives, that would be a breach of the broker/adviser’s duty to recommend suitable investments. Any of these abuses can be grounds for the investor to file a claim against the brokerage or advisory firm to recover his or her losses.
Typically such claims are brought through arbitration rather than lawsuits, although there have been cases where groups of investors have banded together and filed class actions. The advantage of arbitration, which is required by most brokerage firm account agreements, is that the claim gets decided more quickly and less expensively than through litigation in court. In cases involving elderly investors, FINRA arbitration rules allow for expedited proceedings.
According to Craig T. Jones of Page Perry, an law firm that represents investors in securities arbitration claims and lawsuits, “our law firm has seen cases where brokers or advisers have gone to groups of retirees and recommended that they put all of their hard-earned money into a risky private offering. Sometimes unscrupulous advisers will swoop in after a plant closing where a large number of workers have been offered early retirement packages, and then they will make these people promises that they cannot keep.” Such investors are easy prey, because they suddenly have more money than ever before, and they typically have little experience with investing so they are more apt to put their trust in a professional?especially one recommended by an employer or co-worker.
Even honest advisers and brokers can be held liable for investors’ losses if they fail to investigate the offerings that they recommend. “The recent FINRA notice is only binding on broker-dealers, but it is consistent with the standard of care that is required of anyone selling or recommending these investment products,” says Jones. “The law is not only designed to protect you from crooks, but also from financial professionals who are careless with your money.” Jones’ law firm, Page Perry, is based in Atlanta but handles cases for investors all over the country.